Abstract
We construct simple portfolios of hedge funds whose performance characteristics dominate those of funds of funds using three different measures: the alpha, the Sharpe ratio and the Information ratio. Portfolios made up of non-directional funds with the highest Information ratios and/or Sharpe ratios are likely to exhibit a significant amount of persistence and continue to dominate the best funds of funds on all three performance measures. The large risk exposure of directional hedge fund strategies, however, makes them less likely to dominate funds of funds, even when combined with non-directional hedge funds strategies. Overall, these results seem to imply that the extra layer of fees paid to fund of fund managers are largely unmerited, as we can create portfolios of funds, using simple portfolio construction rules and readily available market information, that greatly outperform the best Fund of Funds.
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